IN 1978 The Economist described America’s stock exchanges as “still living in the horse-and-buggy era”. Our correspondent complained that the country’s disjointed equity markets were “slow” and “labour-intensive”, requiring “battalions of clerks, floor brokers, dealers and specialists, whose functions are arcane to the average investor.”
Much of the machinery behind today’s financial markets could still be called arcane, but by no means slow. Exchanges jostle with each other to build the fastest fibre-optic connections to transmit trades across the globe. Firms can make or lose billions of dollars in billionths of a second. But America’s biggest and best-known stock exchange has not quite shaken off its past. Even as its peers in Hong Kong, London, Tokyo, Toronto and Mumbai have abandoned their trading floors, the New York Stock Exchange has retained its famous pit and human criers. Most of NYSE’s volume now flows electronically through a data centre in suburban New Jersey, but nearly a fifth is still traded by floor brokers at its 117-year-old Wall Street headquarters.
Or it was until March 23rd, when NYSE closed its floor to comply with New York state’s stay-at-home order. The pit will partially reopen this week, ending the Big Board’s two-month forced experiment with all-electronic trading. NYSE will invite only a few floor traders back, requiring them to keep their distance, wear masks and stay off public transport. But why retain a trading floor at all? They are a costly, overhead-heavy business, with humans who are slower and more prone to error than algorithms.
The exchange’s management claims that the floor moderates volatility. Jeffrey Sprecher, who chairs its board, told investors recently that human traders promote more efficient pricing, particularly for the end-of-day auctions that help determine daily closing prices. But a recent paper, by Edwin Hu of New York University and Dermot Murphy of the University of Illinois at Chicago, casts doubt on that claim. NYSE’s hybrid auction structure allows floor traders to submit their last orders of the day up to ten seconds before the market’s close, whereas those coming through electronically have to make theirs ten minutes prior to its end. Mr Hu and Mr Murphy find this gives floor traders an advantage in end-of-day auctions. Unsurprisingly, they conclude, the auctions have become more efficient since moving entirely online.
The exchange’s stubborn adherence to the trading floor may owe as much to marketing as to efficiency. “NYSE is promoting an image of ‘the premium exchange,’” says Marius Zoican, a professor at the University of Toronto who studies securities markets. “It’s historic, it still has the famous building, the human touch.” The exchange can claim its prices reflect the perfect blend of human intuition and machine precision. Business-news networks broadcast live during the trading day against a backdrop of bustling traders and flashing screens. Opening bell-ringing ceremonies help create a buzz for newly listed stocks. With favourable access to daily closing auctions, floor traders have no incentive to push for change, either.
Trading floors retain more of a presence in other securities, such as options and metals. These, too, have been forced online by covid-19. NYSE, with Cboe and Nasdaq—two other American exchange operators—closed its options-trading floor in March. Arguably, the pit with the most impact on prices is the “red ring” of the London Metals Exchange, one of the last of its kind in Europe. Even at the LME, most volume has traded electronically in recent years. But five-minute “open outcry” sessions interspersed through the day—during which the ring’s participants shout and signal offers at each other—help determine prices in the global industrial-metals market. On March 23rd, after 143 years, the LME moved its price-setting mechanism to its electronic trading system as well.
Could these changes become permanent? That looks unlikely. NYSE’s options floor, in San Francisco, partially reopened on May 4th. Cboe and Nasdaq plan the same for theirs, in Chicago and Philadelphia respectively, on June 1st. Large traders miss the stability afforded by the floor. In options markets, big orders placed electronically can cause upheaval in markets. Because of the complex nature of options trading, floor brokers interacting with each other can get the prices their clients want more easily than a computer can.
The LME’s ring traders feel the same way, but will not be back soon. A partial reopening with enforced social distancing is impossible in the red ring, according to the exchange’s executives. For now, the LME says its all-digital system is working just fine. Last year it conducted a fortunately timed three-month trial to price nickel electronically, which helped to smooth the switch. Still, ring traders disliked the system during the trial, struggling to lock in their preferred prices for their clients. Some have tried to mimic the ring by trading by phone via the exchange’s inter-office market. “Although we’ve shown things work well without the ring,” Matthew Chamberlain, the exchange’s chief executive, told Reuters last week, “Things work well with the ring as well.”
Trading floors are “going nowhere, fast”, according to Kevin Kennedy, Nasdaq’s US options head. Their importance has, indeed, shrivelled in the 42 years since this newspaper complained about the slow-footed nature of America’s stockmarkets. But they have not disappeared yet. As long as there remain those who want the horse-and-buggy veneer to their trading experience—and have millions of dollars to transact—so will the floors. The old ways are hanging on, albeit at a cost.■